EUR 850.00 For Business Accounts Only

Morningstar | HSBC Posts Strong 3Q Result; the Bank Is Undervalued as Profitability Improves

HSBC delivered a solid third-quarter result as operating expenses were kept in check in the quarter. A higher level of operating expense was a key concern last quarter against management guidance for a positive jaws ratio, or operating income growth to outpace operating expense growth for the full year. Positively, the jaws ratio narrowed to negative 1.6% for the nine months from negative 5.6% at the first half. The near-term operational improvement is certainly a positive and we expect this to continue as the bank is operating on a leaner structure after its restructuring. We expect the bank’s return on equity to steadily improve in the medium term in the context of an improving operating environment, as reflected in rising interest rates globally and third-quarter loan growth of 2% on last quarter, or 6% on the end of last year.

A change of analyst sees our fair value at GBX 880, HKD 90, and USD 58, for the U.K., Hong Kong, and U.S. listings, respectively. Our fair value represents fair price/book of 1.4 times and we believe the bank is undervalued. There is no change to the narrow economic moat rating and stable moat trend. The bank maintains a dominant position in Hong Kong and benefits from funding cost advantage with deposit market share of 20% on a stand-alone basis, based on our estimate. The bank’s U.K. deposit market share is also in line with peers and its competitive position is strong. Our uncertainty rating is revised to high from medium, in line with global peers under our coverage with extensive exposure to global economic conditions. The trade tension is a near-term headwind but the bank is not seeing any negative impact on credit quality. Given the bank’s strong capital position, we expect the impact from an escalation of trade tension is limited to profitability. A higher level of profit in the third quarter and lower risk-weighted assets resulted in a slight improvement in the common equity Tier 1 ratio to 14.3%, from 14.2% in the first half.

Rising interest rates remain a key positive tailwind for the bank. Net interest margin for the nine months of 1.67% was 1 basis point higher than the first half, or 4 basis points higher against the end of last year. This was attributable to improved margins across most divisions but the bank saw pressure on mortgage margins in Hong Kong and the U.K. Generally, banks in Hong Kong have competed aggressively in mortgages given the higher profitability and the low interest rate environment means banks in general can borrow cheaply. However, the 1-month Hibor in Hong Kong increased materially in 2018 as liquidity tightened and this has resulted in system composite interest rates, or weighted funding costs, for banks, doubling to 76 basis points in September 2018 from the beginning of the year. Given HSBC’s strong deposit market share, we expect the bank to fare better than peers as funding costs increase. We expect banks more reliant on wholesale funding to compete less aggressively as funding costs increase and this may ease the pressure on mortgage margins in the near term. For the group, we continue to assume steady increase in net interest margin over the medium term as interest rates normalise. Libor has risen consistently in 2018 while the Bank of England has also lifted interest rates by 25 basis points in August.